Flexing Economic Muscles

As we approached the early April selloff, much of the data suggested that economic activity was expanding. Let’s examine two important pieces of data.

Led by a 5.3% surge in auto sales, retail sales rose a strong 1.4% in March. While some buyers were hoping to jump in front of any tariffs (especially autos), February’s numbers were also respectable. As Figure 1 indicates, sales have been trending higher.

In their quarterly earnings releases, the major banks acknowledged that consumers are spending, according to the Wall Street Journal. Moreover, in its quarterly report, the CEO of American Express (AXP $251) said recent metrics are “in many cases, better than what we saw in 2024.”

But economic growth extends beyond just the ‘stuff’ you and I buy. After being stuck in a sideways pattern for over two years, life is returning to the industrial sector as evidenced by Figure 2.

The only reason industrial production was down 0.3% in March: a 6% decline in output from utilities. Otherwise, manufacturing rose for the 5^th month in a row, gaining 0.3% in March.

Given a massive surge in imports over the last couple of months (U.S. Census), as companies hoped to jump ahead of any tariffs that might be imposed, Gross Domestic Product may be weak or decline in the first quarter (a surge in imports subtracts from GDP).

Meanwhile, Dept. of Labor data points to a low level of layoffs, and job growth has been solid, according to the U.S. Bureau of Labor Statistics.

It added up to economic momentum heading into the recent market turmoil.

Stocks End Volatile Week Higher but Certainty in Short Supply

On Wednesday, President Trump put reciprocal tariffs on hold for 90 days (except China), fueling the third-best daily gain (9.5%) in the S&P 500 Index since WWII, according to Bloomberg.

On Thursday, the president said the pause could be extended.

However, a return to market calm has proven elusive. A 10% tariff remains in place on nearly all countries, while steel and aluminum face tariffs of 25%—the same applies to autos outside the US-Mexico-Canada (USMCA) trade agreement, according to Reuters.

Additionally, tariffs on China are set at 145%, as confirmed by the White House. Economic uncertainty is high, which keeps investors on edge.

Figure 1 illustrates recent declines. The short sell-off in 2020 was the most intense, while the 2022 bear market, associated with high inflation and rapid rate hikes, was more measured.

Due to significant economic and policy uncertainty, investors have shied away from stocks, repricing assets amid a darker economic outlook, i.e., expectations for higher inflation and a sluggish economy (or worse, a possible recession).

Meanwhile, problems are bubbling to the surface in the Treasury market. On Friday, April 4, the yield on the 10-year Treasury hit an intraday low of 3.86% (CNBC). It closed a week later at 4.48%.

Historically, economic and stock market tremors encourage investors to buy Treasury bonds, which pushes yields down. Treasuries have been viewed as a safe-haven asset, as we saw in the 2008 financial crisis and the pandemic lockdown.

That’s not happening today. Why?

Markets are concerned about inflation, which can drive yields higher. There may be some selling among foreign holders of U.S. Treasuries. Hedge funds could also be selling bonds as they unwind leveraged positions to raise cash.

Furthermore, there may be some unease over any upending of the global order that has been in place since the end of WWII, if that is occurring. Historically, the dollar has risen when global markets have been shaken. Today, the dollar has lost value amid outflows into other currencies.

Today’s situation is fluid. It only takes a headline to move stocks, as we saw on Wednesday. Investors seek clarity, including a resolution of trade issues the market doesn’t perceive as harmful.

Alternatively, they are carefully monitoring any shift to a new trade equilibrium, which has been challenging thus far.

Tariff Talk Leads to a Market Correction

“Here’s the interesting thing about the stock market: …It has no gender, ethnicity, or religion… “It’s the ultimate voting machine, reflecting prospects for earnings growth, stability, liquidity, inflation, taxation, and predictable rule of law.” –Michael Cembalest, JPMorgan – 3/12/25

When controversial topics impact market activity, our goal is to preserve objectivity by examining them from an investor’s perspective. In other words, how might events, both economic and non-economic, affect the “prospects for earnings growth, stability, liquidity, inflation, taxation, and predictable rule of law.” This includes tariffs.

Our expertise lies in partnering with you to create and implement financial plans that help you achieve your long-term financial objectives. When domestic or international events impact market action, we aim to convey their impact — what and why — without the shrill headlines sometimes found in the financial press.

Highs followed by a correction

Last month, the market was riding high, and the S&P 500 Index achieved a record close during the second half of February, according to MarketWatch.

In essence, investors didn’t appear to believe the president would follow through on his threat to levy tariffs. Instead, they seemed to view it as a strategy to gain concessions. If push came to shove, he’d relent.

While he has delayed levies on some countries and products, some tariffs have been implemented, generating significant uncertainty.

The most immediate impact is the first 10% pullback in the S&P 500 Index since the second half of 2023, occurring at the recent low on March 12th, according to data from MarketWatch.

Yet, market corrections are common. The average intra-year decline in the S&P 500 Index since 1980 is 14%, according to LPL Research. So far, the S&P 500’s decline has been a modest 10.1%.

Today, investors are re-pricing assets in lieu of the additional uncertainties.

As Mr. Cembalest noted in his research report, “Market consensus had assumed the administration would carefully balance inflationary, anti-growth policies with pro-growth policies. (Instead), it has come storming out of the gate with more of the former than the latter.” Consequently, market volatility has ensued.

Investors and financial markets view trade barriers as an impediment to economic growth.

1. Tariffs may boost inflation. While many expect this to be a one-time boost, concerns have been raised about potential longer-lasting or secondary effects—discuss in a moment.
2. Tariffs may slow economic growth as trading partners retaliate by erecting walls to U.S. exports.
3. While higher barriers to U.S. markets might benefit some domestic industries, overall, however, tariffs lead to increased economic uncertainty, which can undermine business confidence and business spending.

In summary, might we see slower economic growth, leading to slower profit growth, AND higher prices?  That possibility is encouraging investors to re-price assets, i.e., modestly lower stock prices.

Tariffs and inflation

Currently, Fed officials are in the ‘one-time price boost’ camp. That’s one significant reason why the Fed believes it can overlook tariffs and refrain from raising interest rates to combat inflation. Fed Chair Powell even used the term “transitory” last month when referencing any tariff-induced inflation.

The term ‘transitory’ makes economists and investors somewhat uneasy, as it was used to characterize inflation in 2021. As the economy reopened, prices jumped. The surge in inflation was expected to be transitory (temporary), according to Fed officials, until, well, it wasn’t.

We conceptually understand the one-and-done price hikes. Tariff is levied, price rises (something akin to a sales tax increase, though the mechanics are much different), and that’s it.

But what about secondary effects? If tariffed auto prices rise sharply, would domestic manufacturers also raise their prices, forsaking market share for fatter profit margins? Would higher costs for new cars prompt some to consider used vehicles, driving prices higher? Therefore, would auto insurance also rise? Maybe, or maybe not.  It’s complicated.

These exercises can be re-created in many industries. But they are speculative. The end game is unknown; hence, there is a high degree of uncertainty.

Investor’s Corner

Stocks have risen sharply over the past two years. Yet, we are mindful that market volatility may be unsettling, and we encourage a longer-term perspective that avoids decisions based solely on recent market action.

Be cautious about trying to time the market. Market timers occasionally get lucky. But consistently timing peaks and valleys is nearly impossible. Further, wealth creation is about time in the market, not timing the market.

Your financial plan encourages you to make more thoughtful investing decisions, removing the emotional component that may cloud decision-making when stocks are surging or volatility surfaces.